Broomer's Blog

Outlook December 2016

In a presidential race that featured two of the most unpopular candidates in history, it was inevitable that someone appalling was going to be elected. However, Trump's victory has once again left the political pundits and financial markets astounded. Some of Trump's policies will act to stimulate the economy, others will fall flat. The trouble is that we don't have the detail and frankly even if we did, we still wouldn't be much wiser as to whether they will work. However, what we can be sure of is that Trump represents a shift in economic regime away from monetarism and towards more Reaganomic type policies. These will bring greater fiscal deficits and at a time when the Federal Reserve is already tightening monetary policy, risks inflation.

In Europe, there is growing evidence of popular discontent with the direction that the EU experiment is taking. The problems in Europe are obvious and it is equally clear how to solve them. However, there is little sign of any political willingness to tackle these issues head on. Instead, more populist movements are gaining political momentum, despite many having policies that make Trump's look sensible. This is unsettling and ultimately could threaten commitment to the common currency. A break up in the Eurozone would have horrific consequences for European credit and equity markets. However in the meantime, there are good technical reasons why we have not seen a corresponding rise in risk premiums associated with European assets. This presents us with an opportunity to exit positions at attractive prices. This is a low probability, high impact risk but over the long term we should not allow our cautious pessimism to become overly entrenched. Change is precisely what Europe requires.

May and Hammond already risk sounding like castoffs from a BBC motoring show. Boris Johnson's capacity for foot in mouth is even greater than Clarkson's. This is no joke, a few ill considered asides about friends in the Middle East may unpick relations that have taken decades to weave. The Foreign Secretary seems unsuited for the role and we are sure that his talents be better employed elsewhere. Britain needs as many global friends as it can while plotting its intricate path out of the EU. Disturbingly, the EU member states are displaying improbable levels of unity and do not appear prepared to shift one iota on the crucial issue of free movement of people. A serious impasse is emerging and the prospect of 'hard' Brexit looms large. The impact will have far graver consequences than a typical Top Gear fiasco.

We have been through an extended period of relatively relaxed movement of labour, goods and capital around much of the world. At the very least, Trump and Brexit will curtail this. The resulting softening in the deflationary winds will be compounded by the recent OPEC discipline. If it ever did, it now makes no sense for government bonds to be yielding so close to zero. Bond yields must climb. For several years, the Exchequer has been quietly benefiting from the declines in debt maintenance cost. It will take time to be felt, but rising interest payments will drain government finances. The UK government's deficit remains big and genuine pain is beginning to be felt in social services and the NHS. A growth solution while Brexit looms is a fantasy. Significantly higher taxes are the only solution but at least inflation will allow these to be massaged in.

Many companies, especially in the US, have also taken the opportunity to lock into debt at low rates. These companies should benefit, at least in part, from higher inflation. Higher bond yields however will bring higher discount rates for company valuations. We need to think hard about the type of businesses that will be able to offset these with higher growth rates. The market darlings of the last decade are unlikely to be the same ones over the coming years. Financials will likely to be a case in point.